Financial system outlook improved but fragile

Release date

19 May 2010

The outlook for the financial
system has improved over recent months, reflecting a recovery in the New Zealand
economy driven by stronger trading partner activity and a sharp lift in the
terms of trade, Reserve Bank Governor Alan Bollard said today when releasing
the Bank's May 2010 Financial Stability
Report.

"However, the global financial markets remain fragile," Dr
Bollard said. "The sovereign debt concerns facing some European economies
have weighed heavily on financial markets in recent weeks. European authorities
and the IMF have recently announced initiatives to support sovereign debt
markets and to begin dealing with the underlying problems. But there is clearly
a risk of further turbulence if adequate progress is not made.

"As an external debtor country, New Zealand could be vulnerable to any
renewed deterioration in global debt markets. At the same time, the process of
fiscal consolidation could dampen the global recovery, although our major
trading partners in Asia and Australia should be less directly
affected."

Dr Bollard noted that global imbalances have reduced over the past two years
with higher savings helping to shrink current account deficits. New Zealand has
also seen a marked narrowing of its current account deficit.

"New Zealand households have increased their savings, which is positive
for financial stability. It will be important that households maintain a
cautious approach to debt accumulation as the recovery continues."

Commenting on the financial system, Deputy Governor Grant Spencer said that
the New Zealand banks remain in good shape and will benefit from the economic
recovery. Non-performing loans appear to be plateauing out and, notwithstanding
the recent market hiccups, banks have successfully been issuing term debt over
the past year, lengthening their maturity structure and reducing liquidity risk.

"Bank credit growth was restrained through the recession, reflecting
weaker demand for credit by households and businesses and tighter lending
standards," Mr Spencer said. "We believe the banks have the
capacity to meet an increase in demand for credit and doing so will be important
to sustain the economic recovery."

Mr Spencer noted that a gradual rationalisation of the finance company sector
is continuing, with the new more stringent regulatory regime promoting further
consolidation.

"A number of finance companies have joined the extended Retail Deposit
Guarantee Scheme to give them more time to realign their balance sheets. We do
not expect the banks to enter the extended guarantee scheme given there is no
need for them to do so," Mr Spencer said.

"Significant changes to financial sector regulation are occurring
around the globe. New Zealand will adopt measures that improve the soundness of
the financial system while not undermining its efficiency. A new Prudential
Liquidity Policy for banks became effective in April and we expect to make
further changes to the bank regulatory regime.

"The new non-bank regulatory regime should be largely in place by the
end of the year. And the Insurance Bill, giving the Reserve Bank oversight of
the insurance industry, is currently progressing through Parliament."

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